Traditional retailer Macy’s has turned into a speculative play

In the last 12 months, Macy’s stock has declined more than 52%. This is no surprise, as shopping continues to shift away from big-box stores. Nordstrom
NRD, -2.21%
Gap
GPS, +0.46%
, Target
TGT, +0.43%
and Sports Authority, among others, are all struggling with consumers’ shifting their preferences to online shopping. For example, sales at Macy’s were down 5.6% in the first quarter, despite U.S. consumer strength.

This news follows an announcement by Macy’s
M, -1.27%
in January 2016 that the retailer will close 40 stores by the end of the year and reduce expenses by $400 million. Needless to say, it hasn’t been fun to be a Macy’s shareholder recently. With that in mind, however, the stock may be one of interest here, albeit one with a fair amount of risk.

The strength of the U.S. consumer

Macy’s actually beat consensus with earnings per share (EPS) of $0.40 in the first quarter. However, management issued downward guidance to $3.15-$3.40 EPS for fiscal year 2016 (from $3.80-$3.90), weighing heavily on the stock. When discussing first-quarter earnings, Macy’s CEO Terry Lundgren stated that Macy’s, “was not counting on the consumer to spend more” in shifting some of the blame to the current economic environment.

Days after this announcement, however, aggregate U.S. retail sales for April showed the best monthly gain since March 2015, up 1.3%. However, the biggest data point in our opinion was that e-commerce was up 10.2% in comparison to a year ago, as consumers continue to show a strong preference for online shopping.

Further buoying the American consumer is an uptick in wages, as average hourly earnings increased 2.5% in April from a year earlier. Jobs created in April were high quality, primarily in the professional and business services, health care, and financial activities sectors. Unemployment held steady at 5%, a very solid number.

Additionally, consumers’ willingness to spend was displayed in the earnings of Home Depot
HD, +0.03%
and Walmart
WMT, +0.35%
last week. The problem is not the U.S. consumer, the problem is how Macy’s is currently serving the consumer. Thankfully, Macy’s has a plan for that.

Turnaround story

Entering 2015, Macy’s enjoyed five consecutive years of sales and earnings growth, and the company was firing on all cylinders. From Jan. 30, 2009-Jan. 29, 2016, the stock returned an astounding 412%. Then year-end 2015 sales were down 2.5% in comparison to 2014. Macy’s seemed shocked by this shift and used its 2015 Annual Report to address the struggles while naming the report “The Agility to Adapt.”

Retail, as we know it, is going through a secular change due to the wild success of Amazon and other online retailers. Previously, Macy’s online and in-store was run as separate organizations. This is no longer the case. The key for Macy’s is to allow their brick-and-mortar stores to complement their online presence. Examples of the execution of this strategy would be in-store pickup, ease of online returns, and ability to generate additional purchases from online return in-store traffic.

Immediate plan of action

As with all turnarounds, there is an element of trust in management’s vision. After first-quarter earnings were announced in May, Macy’s included an immediate plan of action outlining areas of improvement in 2016:

First, continue to do what is working. Macy’s enjoys an advantage to many retailers, in that the store can be extremely flexible in terms of the products they carry (vs. a Gap for instance). Recent strength has been seen in home goods, beauty and jewelry, while apparel has been weak, as consumers are shifting to a preference of value over brand.

Second, around 35% of Macy’s offerings are exclusive to Macy’s, allowing them some protection from other retailers. These exclusive goods drum up excitement and interest in the store. In 2016, expect exclusive products with supporters including Elton John and Lady Gaga, Shaun White, Samsung, and Brookstone. Also, anticipate Macy’s to add to whimsical merchandise in home goods.

Third, expect a continued heavy investment in online customer support and technology. For example, the fifth direct-to-consumer fulfillment megacenter was opened in 2015 to help support the online growth.

Hidden value

In 2015, activist investors began prodding Macy’s to explore monetizing their real-estate holdings, including ownership of more than 400 stores, to unlock value. These holdings have been valued as high as $21 billion, including flagship stores in Manhattan and San Francisco. Macy’s rejected any notion that they should form a REIT with these assets, but it is apparent the company is making moves toward more action.

In January 2016, Macy’s announced a search for a senior-level real-estate executive and also the engagement of a real-estate investment bank to assist in developing opportunities. In May 2016, the company announced the hiring of Douglas W. Sesler, as the new senior-level real-estate executive and commented that unproductive real estate will continue to be monetized.

So far, Macy’s has announced the sale of a portion of the Seattle store for $65 million for office use development and a $270 million deal with Tishman Speyer to purchase a portion of the Brooklyn store. Both of these deals occurred in 2015 and display Macy’s willingness to capitalize on their real-estate holdings. With a market cap of around $10 billion, successfully monetizing a $21 billion real-estate portfolio could be a major catalyst for the stock.

The risk

We admit that scooping up Macy’s shares comes with plenty of risk. The company has sizeable threats to its core business still lingering, such as how it is going to compete with the likes of Amazon. We suggest carving a speculative piece of your portfolio for turnaround names, and Macy’s is a great fit.

In Macy’s you are acquiring an iconic name, trading for less than 10 times forward earnings, implementing an aggressive turnaround plan, with real-estate holdings potentially worth more than double the current market cap of $10 billion. We like the risk/reward payoff after the recent downturn and look for a significant upside for the stock after management has time to execute its agile turnaround plan.

Disclosure: Clients and employees of Mainstay Capital Management may hold the securities mentioned in this article in their investment portfolios. The securities mentioned may not be suitable for some investors, based on their tolerance for risk or their investment time horizon.

David Kudla is CEO and Chief Investment Strategist of Mainstay Capital Management, a fee-only, independent, Registered Investment Advisor. More information about his firm can be found atwww.mainstaycapital.com. Follow him on Twitter@David_Kudla.

David
Kudla

David Kudla is CEO and Chief Investment Strategist of Mainstay Capital Management, a fee-only, independent, Registered Investment Advisor. More information about his firm can be found at www.mainstaycapital.com. Follow him on Twitter @David_Kudla.

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